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Governance of Financial Institutions  

Guler Aras

Corporate governance is a central issue in business and economics. However, governance in financial institutions is more complicated than in other fields because of the nature of financial services and instruments. Financial organizations are similar to other businesses in terms of their purposes of establishment, but confidence in management and complex risk structures are more important in financial organizations than in other businesses. In financial institutions, there are various areas in which problems arise that are related to corporate governance, including the agency problem and stakeholder protection. The importance of good governance for sound performance of financial institutions was reconfirmed during the 2008 financial crisis, raising the need to understand the agency problems and the efficiency of various corporate governance mechanisms in mitigating them. International organizations, such as the Organisation for Economic Co-operation and Development, the Basel Committee, the International Finance Corporation, and the International Organization of Securities Commissions, have been working with regulators and policy makers to improve corporate governance practices both in nonfinancial and financial institutions. Corporate governance, especially in financial institutions, is essential in guaranteeing a sound financial system, capital markets, and sustainable economic growth. Governance weaknesses at financial institutions can result in the transmission of problems across the finance sector and the economy. Consequently, the effectiveness of governance mechanisms of financial institutions and capital markets after financial crises had significant importance in a period that witnessed an intensive discussion of corporate governance issues with new regulations and the related academic works.

Article

Governance Through Ownership and Sustainable Corporate Governance  

Marc Goergen

Sustainable corporate governance has been defined as corporate governance that ensures corporations are run in such a way that they are sustainable over the long term. Note that for corporations to be sustainable in the long run, they need to ensure the preservation, as well as possibly the enhancement, of their ecosystem. This not only includes establishing and maintaining good relations with their shareholders and stakeholders but also preserving their environment. Here, the term environment should be understood as taking on a broader meaning. Indeed, corporations preserving their environment should not be reduced to mere environmentalism but they should also operate in harmony with the broader economic and social system. Put differently, sustainable corporate governance should also ensure that corporations are run in such a way to avoid future crises, such as the Great Recession. This would require a move away from business models that focus on short-term shareholder value while endangering the survival of the corporation over the long term. Whereas much of the existing literature suggests that corporations should merely maximize shareholder value and that a stakeholder approach will result in vague and often contradictory objectives for the management, long-term shareholder value creation is nevertheless compatible with the corporation looking after the interests of its immediate, as well as possibly more remote, stakeholders. Ultimately, sustainable business practices will not only benefit the corporation’s employees, customers, and the broader society but also its owners. The key question that arises is whether there is a link between various types of owners and sustainable corporate governance. A number of related questions emerge. What different types of owners are there and how influential are they in putting their stamp on how their investee firms are managed? Attempting to answer these questions requires revisiting the premise of the principal-agent theory that owners are typically disinterested from engaging with their investee firms. The main critique of this premise is that, even within the Anglo-Saxon corporate governance system, firms tend to have block holders, and there exist activist shareholders. Further, since the 1980s there has been an emergence—as well as an increase in the prevalence—of activist shareholders. Are some types of owners or shareholders more likely to enhance and maintain sustainability than others? A review of extant evidence on the effects of various types of shareholders on long-term financial and non-financial goals suggests the following. While some types of owners are found to promote and support sustainable corporate governance, the effect of other types is less clear or even negative. This difference in effects could be due to three reasons. First, context, including the national setting, is important. Second, some types of investors, such as sovereign wealth funds, show great diversity in their characteristics and objectives. Finally, the goalposts are shifting with an increasing number of investors embracing corporate social responsibility and environmental, social, and governance issues. Importantly, given the increasingly visible consequences of global warming and societal unrest caused by a worsening of wealth inequality, the transition to a more sustainable society should not merely be the responsibility of corporate owners. Others, including corporate executives and business schools, are key to achieving this transition.

Article

The Governance Roles of Private Equity  

Sophie Manigart, Miguel Meuleman, and Tom Beernaert

Private equity (PE) investors enhance the governance of portfolio companies by installing high-powered boards, structuring the senior management team, installing reward and performance management systems, and advising the portfolio company. The aim is to reduce agency risks and to increase shareholder value. A growing body of literature investigates the real effects of PE buyouts on their portfolio companies. Empirical evidence suggest that PE buyouts do not consider efficiency improvements as their main value-creating strategy, but PE enhances growth rather than efficiency. Researchers’ understanding of PE’s entrepreneurial growth approach to increase shareholder value is limited to date, although it is known that PE portfolio companies are active innovators and that PE portfolio companies extensively engage in acquisitive growth. Financial performance of PE investors can also be driven by transferring value from other stakeholders to the portfolio company after buyout. Does PE buyout’s shareholder value creation come at the expense of other stakeholders, such as employees or customers, or do they also benefit? PE’s impact on employment and wages in portfolio companies has received considerable attention. The effect depends on the institutional setting and macroeconomic conditions and differs across PE groups and by type of buyout. PE buyouts do improve employees’ safety, well-being, and human capital. Research on the impact of PE on stakeholders other than employees is limited. Industry-specific studies uncovered fine-grained actions and mainly negative effects on various stakeholders beyond shareholders and employees. This highlights the tension between enhancing shareholder value at the expense of stakeholder value. Given the continuous development of practices in the PE industry, the governance roles of PE will remain a fertile ground for academic research.

Article

Corporate Governance in Business and Management  

Erik E. Lehmann

Corporate governance is a recent concept that encompasses the costs caused by managerial misbehavior. It is concerned with how organizations in general, and corporations in particular, produce value and how that value is distributed among the members of the corporation, its stakeholders. The interrelation of value production and value distribution links the ubiquitous technological aspect (the production of value) with the moral and ethical dimension (the distribution of value). Corporate governance is concerned with this link in general, but more specifically with the moral and ethical dimensions of distributing the generated value among the stakeholders. Value in firms is created by firm-specific investments, and the motivation and coordination of value-enhancing activities and investment is protected by the power concentrated at the pyramidal top of the organization. In modern companies, it is the CEO and the top management who decide how to create value and how to distribute it among the relevant stakeholders. Due to asymmetric information and the imperfect nature of markets and contracts, adverse selection and moral hazard problems occur, where delegated (selected) managers could act in their own interest at the costs of other relevant stakeholders. Corporate governance can be understood as a two-tailed concept. The first aspect is about identifying the (most) relevant stakeholder(s), separating theory and practice into two different and conflicting streams: the stakeholder value approach and the shareholder value approach. The second aspect of the concept is about providing and analyzing different mechanisms, reducing the costs induced by moral hazard and adverse selection effects, and balancing out the motivation and coordination problems of the relevant stakeholders. Corporate governance is an interdisciplinary concept encompassing academic fields such as finance, economics, accounting, law, taxation, and psychology, among others. As countries differ according to their institutions (i.e., legal and political systems, norms, and rules), firms differ according to their size, age, dominant shareholders, or industries. Thus, concepts in corporate governance differ along these dimensions as well. And while the underlying characteristics vary in time, continuously or as a result of an exogenous shock, concepts in corporate governance are dynamic and static, offering a challenging field of interest for academics, policymakers, and firm managers.